To: Interested Parties

EXECUTIVE
DIRECTOR
From: Maya MacGuineas, Executive Director, The Committee for a
Responsible Federal Budget, at the New America Foundation
Maya MacGuineas
Date: February 2, 2004
CO-CHAIRMEN Re: The President’s FY 2005 Budget
Bill Frenzel
Leon Panetta

DIRECTORS The President’s newly released FY 2005 budget projects spending of $2.4
Roy Ash trillion and revenues of $2.0 trillion, leaving a deficit of $364 billion in
Thomas Ashley
fiscal year 2005. The projection for the FY 2004 deficit is $521 billion –
$44 billion more than the Congressional Budget Office’s January estimate
Charles Bowsher
of $477 billion and an increase of $146 billion from the prior year. Not
Dan Crippen including off-budget surpluses, (most of which are from Social Security)
Willis Gradison deficits would amount to $675 billion in 2004 and $543 billion in 2005.
William Gray, III
Ted Halstead Total spending for 2005 is projected to grow by 3.5% (compared to 7.5%
Jim Jones in the previous year). Revenues are projected to increase by 13% due to
Robert Kerr, Jr. continued strength in the economy.
James Lynn
James McIntyre, Jr.
The Administration now recognizes that deficits do in fact matter, and has
set the goal for reducing them by half within five years. Deficits are
David Minge
projected to decline gradually under their plan throughout the 2004-2009
Marne Obernauer, Jr. period, both in dollar terms and as a share of GDP. In fact, the plan meets
June O’Neill the share of GDP goal by 2006 and the dollar goal by 2007.
Rudolph Penner
Tim Penny However, this objective is met only if one includes Social Security’s
Peter Peterson surpluses. If Social Security is taken out of the equation and only on-
Robert Reischauer budget deficits are considered, the deficit is not cut in half – either in
Alice Rivlin dollar terms or as a share of GDP. Furthermore, the goal of cutting the
Jim Slattery deficit in half over five years is probably unrealistic given what is left out
David Stockman
of the budget (see below), and at the same time, too timid given the
country’s current fiscal condition.
Paul Volcker
Carol Cox Wait Finally, the submitted budget includes some sensible and much needed
Joseph Wright, Jr. budget process reforms. However, these restrictions would apply only to
the spending side of the budget, exempting changes on the revenue side
SENIOR ADVISORS from the controls, both undermining the effectiveness of the budget
Henry Bellmon mechanisms and making them a more difficult sell politically.
Elmer Staats
Robert Strauss
The New America Foundation
1630 Connecticut Ave. N.W. 7th Floor, Washington, DC 20009
(202) 986-6599/ CRFB@Newamerica.net
By the Numbers:

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 *** For more details, see Appendices 1 & 2 ***

Key Points:
Budget Windows
The truncated five-year budget windows used in the budget paint a somewhat
misleading picture of the effects of many of the proposals. Yes, economic and budget
projections are difficult to make well into the future and 10-year projections
notoriously miss their mark. However, it is necessary to track the costs in out-years of
proposals – particularly if they will be markedly different than in the shorter time
frame. Such is the case with the new prescription drug program, the cost of making
the tax cuts permanent, and the lost revenues due to the implementation of Retirement
and Lifetime Saving Accounts, which are structured like Roth IRAs and thus generate
new revenues in the short-run but large costs over time. Additionally, the shorter
budget windows fail to convey what happens to deficits beyond 2009, when they
would again begin to soar under the Administration’s proposed policies.

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What is Missing
Alternative Minimum Tax – The budget only includes a one-year patch for the
downward creep occurring in the Alternative Minimum Tax, which is starting to
affect middle-income earners in a way in which it was never intended. Fixing the
AMT in a comprehensive manner will be quite costly – tens of billions of dollars a
year. The Administration has expressed its intention to fix the alternative tax, but
apparently chose to defer developing a long-term fix.
Security Costs – It is a pretty safe bet that security costs will be higher than budgeted
for in this budget. The Administration included no funding for military operations in
Iraq or Afghanistan. If the specific needs are not yet known, a better approach would
have been to create a security reserve paid for in the budget and to be tapped as
needed. Instead, supplemental requests, which would worsen the deficit picture, are
highly likely in coming months.
Furthermore, it is becoming apparent that growing security needs and, thus, costs are
here to stay at least in the foreseeable future. Therefore, it is time to shed the mindset
that defense and homeland security costs don’t have to be paid for – they do. Just as
in other areas of the budget, choosing not to pay for those costs today means
somebody else will have to tomorrow. Higher security costs can be offset by lower
spending elsewhere or higher taxes, but borrowing to pay for predictable costs is
neither prudent budgeting nor a fair policy.
Social Security – In his budget the President reaffirmed his commitment to
modernizing Social Security by including an individual accounts component as part
of the program. However, the budget sets aside zero dollars to help pay for the
transition to such a plan. All three of the proposals developed by the President’s
Commission would require upfront revenues in order to achieve longer-term cost
savings and a credible commitment to reforming Social Security would at the very
least include a place holder in the budget as was done for the Medicare prescription
drug expansion.
New Medicare Estimates
Given that the Administration has produced cost estimates associated with the
recently passed Medicare prescription drug legislation that are significantly higher
than what they initially agreed to spend or what the Congressional Budget Office
estimated the costs would be, the least the Administration could have done would
have been to find offsetting costs within their proposed budget. (The differences in
the OMB and CBO estimates are primarily due to different assumptions about
participation rates, market behavior, cost growth rates, and timing issues.) Medicare
is projected to be the fastest growing area of the budget in future years. Costs will
simply have to be contained. This past year instead of discussing much needed
reforms for the program, Congress and the President chose to expand it. The country
must come to terms with the spiraling costs of entitlement programs and finding
offsetting costs for the new higher projections for the prescription drug program
would have been a (relatively small) necessary first step given the size of the overall
task.

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Deficits Do Matter
We welcome the President’s recognition that deficits do matter. And it is extremely
important that the Administration was willing to pick a specific fiscal goal – reducing
the deficit by half over five years. A widely shared goal is a necessary first step to
putting the country back on the path to responsible fiscal policy making.
That said, there are a number of shortcomings with the Administration’s approach.
While given the current political environment, reducing the deficit by half may be as
aggressive a goal as is politically realistic (it is after all an election year, which never
bodes particularly well for responsible policy making), given the fiscal environment,
it falls far short of what is needed. The Committee has always maintained that budget
balance over the business cycle should be the goal. Thus, the federal government has
room to run deficits when the economy is in need of stimulus and later run surpluses
once conditions improve. The Administration’s timetable, however, is not nearly
aggressive enough given that the economic projections assume the recovery is already
underway.
Moreover, additional measures are now in order given that the retirement of the Baby
Boomers is just around the corner. Accordingly, a goal of balancing the budget over
the business cycle – excluding the Social Security surpluses – would be more
appropriate and would require additional changes on either the spending or revenues
sides well beyond what the Administration has proposed.

Tax and Spending Initiatives

While the submitted budget has a number of new initiatives, many are relatively small
in terms of their impact on the budget. Some of the more important changes include:
 Extending Tax Provisions – ($11.5 billion in 2005, $79.0 billion from 2005-2009,
and $87.5 billion from 2005-2014.) Provisions include: Child tax credit, marriage
penalty relief, and the 10% individual income tax rate bracket.
 Make Permanent Tax Provisions - ($11.8 billion in 2005, $131.6 billion from
2005-2009, and $936.3 billion from 2005-2014.) Provisions include the new
dividend tax rate structure, the new capital gains tax rate structure, expensing for
small businesses, marginal individual income tax rate reductions, education
incentives, and the estate tax.
 New Saving Incentives – ($3.6 billion in 2005 (increase), $18.2 billion from
2005-2009 (increase), and $7.6 billion from 2005-2014.) The Administration
decided to move forward with its plan for Retirement Saving Accounts and
Lifetime Saving Accounts, which it first floated just before last year’s budget.
Contribution limits would be $5,000 per person for each of the accounts and
income limits would not apply. The accounts, which are structured like Roth
IRAs, where you pay taxes at the time of deposit but not withdrawal, would create
a temporary increase in revenues in the short-term but drain the government of
resources in the future. Thus, the real costs of these saving vehicles are in the out
years and decades and are not reflected in the budget.

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 Additional tax proposals include:
2005 2005-09 2005-14
Health Care 0.3 19.8 54.7
Charitable Giving 1.9 8.7 18.5
Education -- 2.5 16.4
Energy 1.4 6.8 7.2
Total tax changes would increase the deficit by $12 billion in 2005, $175 billion
from 2005-2009, and $1.1 trillion from 2005-2014.

 Total discretionary spending would increase by 3.9%, not including the costs of
the supplemental. Spending for homeland security would increase by 9.7%;
defense spending would increase by 7.1%; and spending on all other domestic
discretionary areas would increase by 0.5%.
 The Agencies that would see the largest budget reductions (in percentage terms)
from 2004 include the Department of Agriculture, the Corps of Engineers, and the
Small Business Administration. The largest increases would go to the Department
of Defense, the Department of State, and the Judicial and Legislative Branches.

Budget Process
The budget includes a number of budget process proposals, most of which the
Committee whole-heartedly endorses. While specific policy choices are also a
necessary component of responsible budgeting – process alone will never be able to
solve the nation’s fiscal problems – budget mechanisms can help provide politicians
with necessary cover for the hard choices involved in getting out of deep budget
holes.
The budget enforcement legislative package that the Administration plans to send
Congress in the near future includes:
 Discretionary Caps - for 2005 – 2009 on net budget authority and outlays. (Caps
on discretionary spending, which were first put into place in 1990, expired at the
end of 2002.) There would be a single discretionary cap and a required three-fifths
vote in the Senate to exceed limits.
 Pay-As-You-Go – would be reinstated and required for mandatory spending but
not revenue legislation. The Committee strongly supports PAYGO
requirements applied to both spending and tax cut legislation.
 Controlling Unfunded Liabilities – through a point of order against legislation
that would cause a deterioration in the unfunded obligations of entitlement
programs (Social Security, Medicare, federal civilian and military retirement,
Veteran’s disability compensation and Supplemental Security Income).
Furthermore, accounting and reporting would be improved by requiring both the
President’s Budget and CBO to highlight any and all legislation that would
worsen unfunded obligations within the specified programs.
 Emergency Designation - where “emergency requirements” would be
characterized as: necessary, sudden, urgent, unforseen, and not permanent. The

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 stricter definition is intended to end the use of the emergency designation as a
way of getting around spending caps.
 Joint Budget Resolution - that would set overall receipts and spending levels for
discretionary and mandatory programs. The Committee has favored joint
resolutions and believes they would encourage the President and Congress to
agree on budget aggregates earlier in the process and then hold subsequent
legislation to those limits.
 Automatic Continuing Resolution – that would set in if appropriations were not
enacted by the start of each new fiscal year. In order to avoid government
shutdowns, programs would be funded either at the levels of the President’s
budget or the prior year’s levels – whichever were lower.

 Other Changes – include: capping advance appropriations at the 2002 levels;

making changes to how the baseline is estimated; and providing the President
with a line-item veto linked to deficit reduction.
Many of these proposals were included in last year’s budget but were not made a
priority. Given that they can play such an important role in improving fiscal
discipline, we hope the Administration will work with Congress to make their
enactment a priority in the coming year.

Conclusion
We are encouraged that the Administration recognizes that deficits do matter and
accordingly, has chosen a specific fiscal goal, which is the first step in resurrecting
the commitment to fiscal discipline. Furthermore, the budget includes a number of
important budget process initiatives that would be extremely helpful in getting the
process underway and we hope the President will encourage members of Congress to
adopt these reforms. (Though they need to apply to both the spending and the revenue
sides of the budget to be effective.)
However in the end, it is real policy choices that will return the budget to balance, or
better yet, surplus. In that vein:

 It is not the time for tax cuts. Tax cuts are not affordable in the short run, when
any plans to pay for them would be better used to reduce the deficit, or the long
run, since a reduction in future revenues should not precede comprehensive
reforms to the country’s over-promised health and retirement entitlement
programs.
 Spending discipline needs to apply to all areas of the budget. No longer should
policymakers look at defense, homeland security, or entitlement spending as
exempt from attempts to contain costs or requirements to pay for spending. When
the economy is weak or unforseen emergencies occur, borrowing oftentimes
makes sense. But no program should be exempt from scrutiny, considered
untouchable, or left on autopilot indefinitely.
 Entitlement reform. In the President’s budget, the long-run projections show that
on its current path, the budget is not expected to reach balance between now and
2080. Spending on Social Security, Medicare, and Medicaid is projected to grow

6
 from 8.8% of GDP in 2010 to 14.3% by 2030 and continue to grow thereafter.
The deficit is projected to grow from 1.4% of GDP in 2010 to 31.6% in 2080. The
longer inevitable reforms to the country’s major entitlements programs are
delayed, the more expensive they will be. While the President’s budget alludes to
these looming problems, it does nothing to address them.
 Hard choices. Budgeting is about making choices. Rarely are they easy. Given
that we are looking at half-trillion dollar deficits in the face, and that the budget
picture gets even bleaker over time, everything needs to be on the table – taxes,
defense, domestic discretionary spending, and entitlements including Social
Security and Medicare. Politicians need to stop promising what they will not do
and get to work figuring out what they will do to improve the deteriorating fiscal
condition of the country. While there are some good ideas in the President’s FY
2005 budget, far more will have to be done to really improve the deteriorating
fiscal environment.

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Appendix 1 – Budget Details

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Appendix 2 – Economic Assumptions